US oil at record output, and investors want companies mindful of 'boom to bust' spending

Key Points
  • The global energy industry descends on Houston on Monday for the annual CERAWeek conference, where a hot topic will be the record-level surge in U.S. energy production.
  • This should be a great year for oil companies, with higher prices, less regulation and a White House that is friendly to the industry.
  • But the focus for U.S. energy companies will also be on discipline, when it comes to drilling and their balance sheets.
A Nabors Industries floor hand uses a towel to wipe drilling fluid from a section of pipe on a crude oil rig outside New Town, N.D.
Daniel Acker | Bloomberg | Getty Images

By many measures, the U.S. oil industry should be having a great year.

It is emboldened by higher crude prices, a White House favoring deregulation, and improving energy demand. But the industry has a different sort of challenge — to not drill too much.

With the relative boom in oil prices, despite recent fluctuations, investors are judging companies more by their balance sheets and do not want to see overexpansion.

"[Companies] could be sowing the seeds of their own demise. They're going to be called to task by their lenders and shareholders at some point," said John Kilduff, founding partner of Again Capital. "They don't have the infinite runway the high-tech companies of Silicon Valley had."

The recent stock market sell-off has not been kind to energy stocks. For the month of February, the S&P energy sector was down 11.3 percent, its worst monthly performance since September 2011.

"I think there's a new game. It's no longer just about production growth. It's also about return to shareholders, and I think the companies have heard them," said Daniel Yergin, vice chairman of IHS Markit, which hosts its annual CERAWeek conference in Houston starting on Monday. "It's a different metric than it was even a year ago."

I think there's a new game. It's no longer just about production growth. It's also about return to shareholders.
Daniel Yergin
vice chairman of IHS Markit

For now the U.S. oil industry continues to increase production. In November the United States produced a record 10.057 million barrels a day, surpassing Saudi Arabia due to its production cutback. While that number has fluctuated, the United States has produced more than 10 million barrels a day in recent weeks, according to the Energy Information Administration.

The risk for the market, with higher oil prices, is that it could again become oversupplied, as it was before the OPEC-Russia deal to cut production.

"There's a tension that the stronger the oil markets or oil prices become, the more the improvement in economics get, the more you would think you want to spend more. Then there's more supply," said Dan Pickering, co-president of Tudor, Pickering, Holt. "OPEC can spoil the party with more production or coming back early, and the U.S. can spoil the party by ramping up their activity."

During the deep slump in oil prices, which bottomed in 2016, the U.S. industry became more technologically savvy and learned to make wells even more productive, through technology like horizontal drilling. Yergin said the emphasis among industry leaders remains on costs savings.

"I think it's a further drive for efficiency, and that's going to be one of the really big themes. They need the efficiency now not just to deal with lower prices; they need it so they can deliver return to shareholders," he said.

With the exception of refiners, energy stocks have been battered even as oil prices improved. The stocks of exploration and production companies, transport companies, equipment and services companies and integrated oil and gas companies have all been hit in the last year.

Pickering said the emphasis on discipline and balance-sheet strength has occurred as shareholders are applying pressure.

"They are buying companies that are more disciplined, and they are selling companies that are less disciplined. There would be more spending if companies could do whatever they wanted," he said. "It's the balancing of the capital discipline in the balance sheet and the returns you can get. It's a tightrope act, and shareholders are weighing in, along with boards."

Saudi Aramco, EVs and NAFTA are big topics

There is expected to be a heavy focus at CERAWeek on infrastructure spending to improve the transportation network required to move that growing oil output. That will no doubt turn the talk to President Donald Trump's plan to slap tariffs on imported steel and aluminum. Pipeline construction relies heavily on foreign steel.

The conference has an agenda that includes the biggest names in the energy world. This year OPEC Secretary General Mohammad Barkindo will attend, as well as government officials, like Energy Secretary Rick Perry and U.S. Interior Secretary Ryan Zinke.

IEA: A lot can change in oil market in the coming months
IEA: A lot can change in oil market in the coming months

Saudi Aramco CEO Amin Nasser speaks Tuesday, and the gathering will also hear from top executives from ExxonMobil, BP, Total, Petrobras, ConocoPhillips and others. Attendees will hope to hear from Aramco about its plans to go public in the world's largest IPO.

More CERAWeek coverage:

Energy can bring angry NAFTA nations back to their senses

The little industry that can take a big bite out of oil demand

Shell warns of an LNG shortage

General Motors CEO Mary Barra is also speaking. There are a number of sessions on electric vehicles, and changes in transportation will be a big part of the discussion, as the industry assesses the future requirements for fossil fuels. IHS Markit predicts that oil demand will continue to grow into the mid 2030s before plateauing, due to more fuel-efficient gasoline-driven cars as well as electric vehicles.

NAFTA could also be a big topic, with a panel Wednesday featuring the top energy officials of the United States, Canada and Mexico. Energy Secretary Perry joins Canadian Natural Resources Minister James Gordon Carr and Pedro Joaquín Coldwell, Secretary of Energy, Mexico, in a discussion on their common interests and challenges. The latest round of talks to revamp the North American Free Trade Agreement conclude Monday.

Last year at CERAWeek, oil ministers from Saudi Arabia and Russia were in attendance, and they publicly reaffirmed their commitment to their production deal, which has helped bring oil back above $60 a barrel. A year ago West Texas Intermediate was in the high $40s and low $50s per barrel.

The reduced output, largely from Saudi Arabia, along with declines in Venezuela, have left an opening for the United States to send more oil onto the world market, and it has helped the growth in U.S. exports.

OPEC's Barkindo is reportedly meeting with some U.S. oil industry investors and executives at the conference, as they did last year. Unlike OPEC nations with state-owned production companies, the U.S. industry is made up of a multitude of companies, from super major Exxon to mom-and-pop drillers. The U.S. industry turns the taps on or off based purely on economics.